Measuring Market Risk Appetite

I had the pleasure of meeting Christopher Verrone, Managing Director and Head of Technical Analysis at Strategas Research Partners last night. He came to speak to the Northern Ohio Chapter of the Market Technician’s Association, a new start up project I am involved in. It is always great to listen to other technicians walk through their process and hear first hand what they find important and how they think. I find it builds a better understanding in my mind as to how I think about the same issues.

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Tonight Christopher walked through his process focusing on a few key macro secular ideas that are bundled in the thought that the stock market is possibly just starting a very long term secular bull market. One big one he mentioned was airline stocks as a long term bullish play as well as Japanese stocks. He also sees Crude Oil continuing lower and pointed to the fact that of the 23 analysts that report to Bloomberg their forecast for WTI Crude ($CL_F, $USO), not one of them has a year end 2014 target below $75/barrel despite the price currently at about $67/barrel. Sentiment is not nearly bearish enough.

But when asked what is the one indicator that he could not live without, the stranded on a desert island question, his response was the ratio Banks to Gold. This he says is a very good measure of risk taking and thus where stocks may go. If the ratio is falling then Gold is outperforming and it is a risk off environment, but if it is rising then risk is being taken. From this measure (and many other factors) he suggests that maybe the secular bull market is just getting started.

kbe gld

I took a look at this ratio and it does tell an interesting story. The chart above shows the Bank sector ETF ($KBE) against the Gold ETF ($GLD) on a monthly basis since its inception in late 2005. And what does it show? The ratio had a peak in October 2007 as the market started to rollover and fell into the March 2009 low where it bounced. Risk off. From that point there has been a sideways consolidation until a channel break in late 2013. Risk on. Christopher suggests (through other indicators) that the risk on environment actually started at the November 2011 low, the last bottom in the channel. Seems like a pretty good indicator over the last 10 years.


 

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